Tuesday, 23 June 2009

The biggest "theme" to yesterday's sell-off was the renewed doubt about the viability of the global de-coupling thesis. The major casualties were commodity related stocks, industrials, shippers, transportation and some of the emerging markets and what might loosely be called the China play . It raises again the questions that many have been asking over the last year especially, about just how much economic growth can be relied upon in the absence of robust demand from those traditional bastions of consumerism - the USA, UK and other parts of western Europe.

Although more and more analysts and investors are coming to the view that the US and other developed economies could be in for a hard slog with a recovery, when it does come, being anemic at best, the bulls have been inspired by the notion that the BRIC countries are sufficiently robust to make it without the "dynamism" of the more advanced economies. The thinking goes that they will be able to withstand the decline in the previously voracious appetite of US consumers by tapping into their domestic markets for alternative sources of consumer demand. The skeptics are quick to point out that there is just not sufficient depth of demand yet within the BRIC economies to pick up the slack left from US/UK consumers that are tapped-out and credit fatigued.

Without doubt, this debate will continue to rage on, but from time to time the over-enthusiasm of some traders in pushing commodities and the re-inflation trade into mini-bubbles will result in the kinds of collapses that some of the decoupling plays experienced yesterday - for example Century Aluminum (CENX) was down by more than 15%, Freeport McMorran (FCX) lost more than 11% and Excel Maritime (EXM) and Dryships (DRYS) were both down by more than ten percent.

In general terms this underlines the potential for serious vacuums to be found below a lot of stocks that have benefited recently from the high frequency rotation and arbitrage strategies being implemented by a lot of Wall Street firms and hedge funds. While these very sophisticated algorithmic strategies can provide the appearance that all is well and the recovery is gaining momentum and foster liquidity (in the absence of committed selling), if there is not a critical mass of fund managers and other vested constituents wanting to preserve the gains of the last three months, the algorithms are abruptly faced with a complete absence of liquidity except on iterating through a series of declining bids.

Questions are now being asked about how large this correction will turn out to be and whether it is now a relatively one way market downwards to a re-test of the March lows.

I would not be surprised to see the S&P 500 drop to a retest of the 875 level where support may well be found from fund managers looking to put some beaten up stocks in their portfolios for the customary end of quarter window-dressing. However my intuition is that July, August and September could prove rather troublesome for global equities in general and it would not be surprising to see the S&P 500 with a seven as its first digit again.

Approaching the more awkward question of whether the March low will hold, my view is that, if further systemic panic can be averted, it is most likely that even if the March low is re-tested it will most likely hold. On the other hand, if the abundance of sovereign debt auctions stretching out into the future as far as the eye can see, should bring forth the shock, that as central bankers begin to retreat from QE policies, there are just not enough buyers who want to be the proud owners of Treasuries, gilts, bunds etc. other than the central banks, then all bets are off. In such dire circumstances the last bout of financial panic could be surpassed by an even more severe version brought on by the realization that all of the aces have already been played by policymakers and central banks.